Question

A firm is must choose to buy the GSU-3300 or the UGA-3000. Both machines make the firm’s production process more efficient which in turn increases incremental cash flows. The GSU-3300 produces incremental cash flows of $26,703.00 per year for 8 years and costs $99,508.00. The UGA-3000 produces incremental cash flows of $28,292.00 per year for 9 years and cost $126,725.00. The firm’s WACC is 8.82%. What is the equivalent annual annuity of the GSU-3300? Assume that there are no taxes. round to 2 decimals

Answer 1

Solution :- Equivalent annual annuity (EAA) = Net present value / Cumulative present value factors.

Cumulative present value factors for 8 years at 8.82 % = [ 1 - (1 + WACC)-Time period ] / WACC.

= [ 1 - (1 + 0.0882)-8 ] / 0.0882

= [ 1 - (1.0882)-8 ] / 0.0882

= (1 - 0.5085) / 0.0882

= 0.4915 / 0.0882

= 5.5726 (approx).

Net present value of GSU-3300 = Present value of cash inflows - Present value of cash outflow.

= 26703 * Cumulative present value factors for 8 years at 8.82 % - 99508

= 26703 * 5.5726 - 99508

= 148805.1378 - 99508

= $ 49297.1378

Accordingly, Equivalent annual annuity (EAA) of GSU-3300 = 49297.1378 / 5.5726

= $ 8846.34 (approx).

Conclusion :- Equivalent annual annuity of GSU-3300 = $ 8846.34 (approx).